10 facts you need to know when purchasing or selling a practice (Proceedings)

You have made the decision to sell. It is probably one of the most significant decisions you will make in your working life. Your practice and associated real estate is also probably your largest and single, most important asset. It may also be the case that your practice sale will be the main source of your retirement fund. The legal and tax structure of your transaction will play a significant role in how well you are protected for your future and how much cash you will ultimately walk away with. It's not the gross sale price that's most important; it's the amount of net cash after tax that you walk away with. Don't underestimate the importance of your professional advisors. They can make a significant difference in the final result of your transaction.

Today, age 65 may be the time when you collect social security but, with current medical advances, many are easily living into their 80's. With 20 to 25 years of good life remaining, age 65 is longer the age to absolutely stop working. Now, it would be nice to know that you have spent your working career not just making a good living and enjoying practice life, but also by rewarding yourself with an asset able to fund your retirement. This, along with other savings, will allow you time to enjoy the many years of life past age 65, independent of work.

To begin this process, it is extremely important to have a practice valuation done at least five years before planning the actual sale. This will provide adequate time to change the hospital cash flow if you are not satisfied with the initial valuation. Most hospital values are driven by the hospital cash flow in excess of amounts paid to the owner veterinarian(s) for their time devoted to veterinary services and management activities. Too often, practitioners make promises to associates for buy-in opportunities before they have completed the valuation and then are not satisfied with the results. At this point it may be too late to make significant changes. Sellers then sometimes take back offers already made, and, at this point, a good associate may be gone.

With the increasing number of baby boomers reaching retirement age, many practices will become available for sale, which is great for buyers, but maybe not so great for sellers. The pool of sellers will outnumber the amount of buyers, and corporate buyers will be more selective in their decision as to which practice to purchase. The number of veterinarians who enter the profession and want to own practices has and will continue to dwindle. The gender issue is an influencing factor, and we are seeing situations where more than one DVM may be stepping up to the plate to purchase a practice through a partnership venture. The rule of supply and demand will prevail. The successful practice will be a practice that has practiced a good quality of medicine and is adequately equipped with both medical and office equipment. The practice has also maintained adequate a fee schedule and developed good cash flow. It is predicted that practice buyers will not look at just the purchase price. They will not be afraid to spend good money for an opportunity that they believe provides them a good return on their investment. Other factors they may consider are: Location; facility, it's age and condition; whether it is owned or leased, and if leased what are the lease terms; demographics; practice stability; revenue/earnings growth potential; mix of services delivered; ability to transition the practice; staff quality; and effectiveness of the management systems.

There are also lenders now willing to loan doctors a good part if not all of the money for these opportunities if they have good credit. The basic criteria is that the practice will be successful enough to return the buyer a normalized salary for the provision of veterinary services and a management fee, and also provide enough excess cash flow to make the monthly note payments over a reasonable period of time, Today, that is a 7- to a 10-year period of time. These practices can be single-doctor practices that have performed exceptionally well but will most likely be multiple-doctor hospitals. This does not mean that they are single doctor owned, but are more likely to have more than one practitioner. They will also most likely be hospitals with $1 million or more of revenue, and will be well established in the community with a good location.

When it's that time to sell, make a clean break. Don't make the same mistake as many other practice owners who are selling the practice and proceed to negotiate sales, especially with associates, with a lot of strings attached.

In contemplating the sale of your practice, consider these 10 important facts.

1) Potential purchasers of your practice may be right around the corner

When considering to whom you might sell your practice, potential buyers may be in your surrounding area. My suggestion is that you make a list of potential buyers close by and contact them for lunch to determine if there is any interest in acquiring your practice. The profession is dealing with market saturation in many geographic areas, and there are too many practices duplicating fixed overhead costs. These lead to financial inefficiencies that hold down practice valuations and purchases prices. A practitioner in your area may recognize these inefficiencies and may be willing to pursue a purchase. It may be a close colleague that is out of space and looking to expand, or your practice facility could provide the perfect professional leap and add to practice sales volume as well. One should never minimize the logistics of combining two hospitals together though. It can be difficult merging two practice staffs and clients together especially when there are two different and distinct practice cultures. These issues must be explored and resolved before considering a move in this direction.

2) Practice valuations are only the starting point for determining how much your practice will be sold for.

Practice sales are a negotiated process and the selling price is only one part of that process. Valuation is an art. There is never one price that can be considered the only price to be paid for a practice. In most instances, if you had three valuations completed by competent valuators all with the same level of knowledge and skill, you will still get three different values. It does not mean that any one of the valuations is wrong. It means that each valuator has determined an opinion based upon their interpretation of the facts and circumstances. What should happen, however, is that the valuations are close, within 10% of each other. If valuations are far apart, then interpretation of the facts and circumstances may have been misunderstood. Also, the price isn't always the most important piece to the sale. It can be the sale structure and the price together that can have a greater affect as to ultimate deal and the amount of cash you take home.

3) Your practice entity type can make a big difference in how much cash you walk away with. Know what you're selling.

Most practice sales are structured as asset sales, but not always. If it is not an asset sale, then it is a stock sale. Practice's structured as sole proprietorships, partnerships; limited liability companies (LLC) treated as sole proprietorships or partnerships and S corporations will be sold as an asset sale and not create the same tax issues as a C corporation. The C and S preceding the corporation name refer to provisions in the tax code. The sale of C corporations as an asset sale results in double taxation. Conversion to an S corporation to avoid the double taxation takes 10 years to effectuate. Make sure you know what entity type you are for tax purposes and discuss any issues you may have with your tax advisor. Don't wait until you are ready to sell before you address any looming entity/tax issues.

4) The allocation of the sale price can impact how much taxes you will pay.

The sale of certain assets has a different tax treatment than others. The sale of inventory and accounts receivable as well as entering into a covenant-not-to-compete creates ordinary income taxed up to 35%. The gain from the sale of equipment and real estate to the extent of depreciation is taxed at 25%. The sale of goodwill and remaining gain from the sale of equipment and buildings is taxed at 15% along with the sale of corporate stock. It is important to understand these tax rates when determining how to allocate the agreed-upon purchase price for the practice and real estate. As long as the negotiation of the allocation is at arms length and resembles fair market value, the agreed-upon allocation should pass IRS approval. Make sure the allocation is stated in the sales contract and IRS form 8594 is completed by both the purchaser and seller and attached to the year of sale tax returns for each respective party.

5) Not selling the practice real estate can be a stumbling block to completing a sale.

Don't be married to the real estate. It is a known fact that a good a deal of practice worth lies in its location. The transfer of that real estate to the purchaser can be viewed as necessary to retain the practice's value. While keeping the real estate can be viewed as a good investment, it is not the only investment you can make. Don't let the holding of the real estate kill the practice sale. If you don't sell it today, you are most likely going to have to negotiate when you will sell it. You also may have to agree on a purchase formula or purchase price today for the sale at some future date. A practice sale without the real estate is also looked on less favorably by the majority of lenders because they like to take the practice real estate as additional collateral for their loan to the buyers. If you have no mortgage on the property, it may make sense for you to hold the mortgage on the property and collect the interest on the note. A word of caution; if there is a bank involved; you will most likely have to take a second position for collateral. Consider an IRS code section 1031 tax deferred exchange if you can acquire similar property that you might want to hold after the sale. In this scenario, you could still be a real estate investor and defer all of the taxes associated with the property sale.

6) Your ability to continue to work in the practice should not be a stumbling block to completing a sale.

If its time to sell the practice and you are committed to the process, don't stand on ceremony about dictating about how much or how often you will be working in the practice. There is always a time period of transition that is necessary where sellers should commit to assisting with the transition of the client base but at some point, sellers have to let go. Make sure you negotiate what your working arrangements will be once the practice is sold. Be flexible. If you have a desire to continue to work, hopefully you can work out a convenient schedule that meets the needs of both the buyer and seller. If you do continue to work, remember, you gave up control the day you sold and most likely will have no further management duties or functions. In most instances, you will enter into an employment contract, but in many states, employment is "at will" and you can be released from service with no notice.

7) You don't need to be the mortgage holder when the practice is sold.

When it comes to the sale of a partial interest in the hospital, arranging financing can be tough. However, when it comes to the sale of the entire practice, many financing options are available. When one considers the sale of their practice, the significant price tag that might be associated with it should not be a stumbling block to the sale. Lenders will, in many cases, lend for a practice purchase of $1 or $2 million. The major criterion is that cash flow from the practice can support the loan over a reasonable period of time, which is defined as somewhere between 7 and 10 years. Many sellers have less than a 20% down payment usually required for conventional financing, but the availability of SBA loans and lenders who specialize in lending to the veterinary profession will make loans for the right deal. Many of the veterinary boutique lenders will make practice loans with no money down if the purchaser has good credit. Real estate added to the transaction can even make it easier.

8) An associate buy-in can create a good transition plan to retirement.

But the decision to add an owner should not be made without a sound rationale for doing so. The motive is likely to be different for each practice, or even change every time a practice adds an owner. There also may be some compelling reasons why a practice should not choose a certain associate. A person should be made an owner only if he or she has the attributes of a productive owner. Sometimes, a staff member is considered for ownership to prevent the individual from leaving the practice. But if he or she does not qualify, it will be less harmful to the practice to lose that person than it would be to have an unsuitable owner. Likewise, associates should not be promoted to owner merely because they have been faithful employees for many years. The qualifications of an individual are far more important than quotas in determining the appropriate number of owners.

When an associate has been identified as a candidate, there should be a period during which the person is given duties that will allow the current owners to observe his or her competence to function as an owner. One way to do this is to delegate management or administrative functions to that person and award the commensurate rank. Generally, the promotion of associates to owner should be based on their overall ability. A single favorable attribute should not be weighted too heavily. By contrast, a singular adverse factor may eliminate a person from consideration. Few practices can afford to have any significant reservations about an owner. For example, if it develops that the candidate has questionable administrative ability or lacks the capacity for full-client responsibility; such deficiencies will obviously preclude his or her admission as an owner.

Manifest technical proficiency is the baseline criterion that one needs to be a credible candidate for ownership consideration. The following list gives the baseline characteristics to look for in prospective owners; honesty and integrity, self-starting, moral courage, loyalty, social presence, appearance of maturity, compatibility with owners (team player), the desire and ability to learn new skills, entrepreneurial nature, dedication to the veterinary profession, dedication to the practice, desire to serve clients, strict adherence to professional ethics, technical competence, self-improvement through CPE and reading, special expertise, and experience.

An associate candidate should also have the ability to contribute to the practice's growth. For instance, to what extent can an ownership candidate encourage existing clients to use all of the hospital's services; expand services to existing clients; attract clients to the practice or assist others in so doing; and make positive contributions to the practice's recruitment, education, development, and staff retention efforts? An owner should also have leadership skills. Leadership is a multifaceted trait that refers to an individual's ability to motivate, develop, and be respected by subordinates; to conceptualize a problem and be innovative in reaching a solution; to inspire clients, to take a positive and aggressive attitude in approaching one's responsibilities; to assume responsibility and authority with discretion and judgment; and to manage one's own time, as well as that of subordinates.

People who are potential owners of the practice should have most of the personal traits that make one a veterinary professional in the true sense of the word. The following list expands the traits discussed in the preceding paragraph; think analytically, possess good verbal and written communication skills, persevere in problem solving, maintain the confidence of staff, other owners, and clients, work well with people, demonstrate initiative, imagination, resourcefulness, and independent thinking in developing and retaining clients, complete assignments on time regardless of workload, and see civic involvement as a responsibility, not a duty.

Last, an ownership candidate should have business acumen, as evidenced by a history of making sound business decisions about client acceptance and retention; setting fees; diplomatic but proper billing and collection efforts; efficiency and effectiveness in performance of administrative activities; and riding out business reversals in a cool and mature manner.

9) Don't purchase a lot of new equipment or make major building improvements within two years of the sale date.

If you do, you will most likely not collect the full benefit from your expenditures when you sell. In most instances, it is better to sell the practice with its inefficiencies and let the new owner make the purchases. It may mean you settle for less, but not as much less then if you made significant purchases or improvements. If you sell the practice but keep the real estate, don't be surprised if the practice purchaser requests a building inspection. If major flaws are found at that time, you will most likely be requested to make whatever repairs are necessary to put the building in a workable condition for the purchaser. Under these conditions, you may be better off making the improvements before the sale. Issues such as these that go unaddressed can kill a transaction.

10) Corporate buyers are still an option and one should not look past merger opportunities.

Corporate buyers are still available for those who want to make quick transactions or see no other avenues to create a sale. You may consider a corporate buyer over putting the practice up for sale with a broker. One should consider the use of a broker carefully. The main advantage of a broker is that they can bring buyers and sellers together. They create a market. However, it comes with a cost and it can be expensive. Many brokers take their commission on the sale of the practice and the real estate. Many corporate buyers are becoming more selective in what they are looking for in a practice. You may not fit their criteria. Also, many times they want a work commitment from you to help create the transition. That work commitment can last anywhere from one to two years. The corporate buyer typically does not want to buy the practice real estate. Another alternative to consider is the practice merger. Look to local practices for opportunities to create mergers and create a transitioned way out of practice.